Structured Notes

For a plain vanilla bond structure, the (1) coupon interest rate is either fixed over the life of the security or floating at a fixed spread to reference rate; and (2) the principal is a fixed amount that is due on a specified date. There are bonds that have slight variations that are common in the marketplace. A callable bond may have a redemption date that is prior to the scheduled maturity date. The option to call the bond prior to the maturity date resides with the issuer; the benefit of calling the issue depends on the market interest rate at which the callable bond issue can be refinanced. Similarly, a putable bond has a maturity date that can be shortened, but in this case the option resides with the bondholder; if the market rate on comparable bonds exceeds the coupon rate, the bondholder will exercise. A convertible bond typically has at least two embedded options. The first is the bondholder's right to convert the bond into common stock. The second is the issuer's right to call the bond. Some convertible bonds are also putable.

Callable, putable, and convertible bonds are considered traditional securities, as are other similar structures such as extendible and tractable bonds.1 There are bonds with embedded options that have much more complicated provisions for one or more of the following: interest rate payable, redemption amount, and timing of principal repayment. The interest or redemption amount can be tied to the performance or the level ...

Get Introduction to Structured Finance now with O’Reilly online learning.

O’Reilly members experience live online training, plus books, videos, and digital content from 200+ publishers.